Espirito Santo loan strains Portugal-Brazil telecoms merger

Mon Jul 14, 2014 9:20am EDT

* PT loaned its cash to BES group company Rioforte in April

* Sources say PT executives already knew of family's troubles

* Rioforte may not be able to repay at Tuesday deadline

* Default risks hurting PT's planned merger with Brazil's Oi

* PT shares down 30 pct this month to historic lows

By Sergio Goncalves and Leila Abboud

LISBON/PARIS, July 13 (Reuters) - Investors in Portugal Telecom, and notably its Brazilian merger partner Grupo Oi, should know by Tuesday whether more than $1 billion it lent in April to a vehicle of the troubled Espirito Santo family is being repaid on time.

Fears of a default by holding company Rioforte have already angered the Brazilians, who say they did not know of the loan. But a revelation that executives at Portugal Telecom, in which the family has a significant stake, knew the Espirito Santos had problems before handing over the cash could raise new questions.

The loan of 897 million euros in 3-month commercial paper maturing this week were agreed by PT managers at a meeting in April, people familiar with the discussion told Reuters. Though problems at Rioforte's owner were made public only in May, they said PT officials already knew it was facing some difficulties.

They still transferred the funds, which PT had been holding in cash or short-term instruments linked to bank accounts, those people added. On June 30, PT said the two issues of 3-month commercial paper paid an average annual return of 3.6 percent.

Portugal Telecom declined comment on whether its officials knew of the difficulties at Espirito Santo International or on why it bought commercial paper from Rioforte, 100-percent owned by ESI and the owner of assets ranging from hotels to tropical plantations. The investment was equivalent to 38 percent of the cash and equivalent investments that PT reported at end-March.

Rioforte has not commented on its repayment plans. It is due to repay 847 million euros on Tuesday and 50 million on Thursday to PT, in which family-founded Banco Espirito Santo has a 10-percent stake. BES is in turn indirectly part-owned by Rioforte and has said it may face losses on its exposure to the family.

There was no immediate comment from Grupo Oi. It has sharply criticised PT for not disclosing earlier a loan deal that has embroiled the merger in turmoil at the Espirito Santo group and at BES, Portugal's biggest listed bank, that has shaken investor confidence in the country and ruffled stock markets worldwide.

MERGER TERMS

The Brazilian phone company agreed in October to a merger giving PT shareholders 38 percent of the new group. It may seek to rework those terms as fears of exposure to the Espirito Santo empire has helped wipe a third off the value of PT's stock, driving the phone company's market value to 1.6 billion euros.

Bankers working on the merger, major shareholders in the two firms and sources close to the Brazilian government do not expect the deal to fall through, however, as neither side would benefit and unwinding it would be difficult.

On the loan to Rioforte, PT might extend or restructure the debt to ensure that it recovers at least part of the funds, credit analysts and investors following the situation said.

But Oi could push for a change in the merger terms to reflect PT's lower value if it loses the Rioforte cash.

Under the original terms, PT's equity value was 1.9-2.1 billion euros, and PT was to end up with 38 percent of the new company. That could fall to as little as 20 percent if its valuation were revised to reflect a loss of the cash, according to credit analysts and investors speaking to the company.

Beyond the financial loss, the Rioforte loan risks poisoning relations between PT and Oi managements ahead of a union intended to make both firms stronger by creating a carrier with 100 million subscribers and $19 billion in annual revenue.

Oi has vowed to protect its interests. Its representatives quit the PT board in protest when told of the Rioforte deal. Brazil's state development bank called the loan inconsistent with "minimum standards of good corporate governance".

"ATTRACTIVE" LENDING

On June 30, Portugal Telecom said of the deal: "Treasury operations are carried out in the context of analysis of various short-term investment options available in the market and taking into account the attractiveness of the remuneration offered and are monitored and approved by the Executive Committee."

Company records show Chairman Henrique Granadeiro and Chief Financial Officer Luis Pacheco de Melo are on the executive committee. A 3.6-percent return compares to under 0.5 percent on Portuguese government 3-month bills. European Central Bank data indicates returns around 2 percent are typical on three-month euros lent to major European banks and commercial borrowers.

Portugal Telecom has not said why it invested so much of its liquidity in one firm's commercial paper instead of keeping cash in banks, an option that carries a much lower risk of default. Firms typically opt to keep a limited portion of their excess cash in commercial paper because it offers a higher return.

PT, which owns 2.1 percent of Banco Espirito Santo, said in its June 30 statement its investment was based on a 14-year-old "strategic partnership" under which PT provided communications services to BES and the bank was preferred provider of financial services to PT. According to a person involved in the family holdings, PT has invested before in Espirito Santo companies.

Portugal Telecom had been investing in the debt of Rioforte owner Espirito Santo International for more than a year, that person said. On May 21, BES disclosed a "serious financial condition" at Luxembourg-based ESI. Luxembourg's regulator has launched a probe into the Espirito Santo family holdings.

The tie-up between Portugal Telecom and Oi is part of a broader push by phone companies to bulk up via a wave of consolidation in Europe and the United States.

For both companies the deal was aimed at resolving specific weaknesses: Oi's big debts have thwarted its ability to invest in its network; PT had a small and sluggish home market.

An official from one of the 10 biggest shareholders in Portugal Telecom told Reuters that the company was working hard to resolve the Rioforte problem and safeguard the merger:

"Calling the merger off doesn't help anybody and it would be technically very difficult to do," the investor said.

"I hope that common sense will prevail." (Additional reporting by Axel Bugge, Guillermo Parra-Bernal in Sao Paulo; Editing by Alastair Macdonald)